EXCERPT: 'Hot, Flat, and Crowded,' by Thomas L. Friedman

Here's how it worked. The mortgage broker who first sold a family a mortgage and then passed it off to a bigger financial institution, like Fannie Mae or Citibank, knew that he would be "gone" if and when the family holding the mortgage defaulted: He would no longer own the mortgage—Fannie or Freddie or some investment bank would. So there was no risk for him personally in the high-risk deal. And he told the family that the same was true for them. There would be no problem if it turned out they couldn't make the payments because "you'll be gone"—because housing prices would always go up, they could just flip the house for more than they paid for it, or just walk away. The rating agencies, whose fees and revenues depended on how many of these bonds of subprime mortgages they got to rate, had a great incentive to give them high ratings so they would sell more easily and therefore more investment houses and banks would want to use their rating services. And if those bonds blew up, well, said the raters, IBG—"I'll be gone." The investment banks had a great incentive to bundle more and more mortgages into bonds and sell them around the world, because the fees were huge, and as long as they didn't hold too many on their own balance sheets, if they blew up, who cared? IBG—"I'll be gone."

To put it another way, the whole system depended upon people who originated the risk profiting from that origination, then transferring that risk to someone else and never having to be responsible for it afterward. So people who never should have been taking out mortgages took them out, people who never should have granted them granted them, people who never should have bundled them bundled them, people who never should have rated them AAA rated them AAA, people who never should have sold them to pension funds and other financial institutions worldwide sold them. And companies that never should have been insuring them, like AIG, insured them, without setting aside sufficient assets to cover a massive default. Everyone just assumed they could profit personally in the short term and never have to worry what happened in the long term after they passed the bond along.

President Obama, in unveiling his own plan to regulate markets after the 2008 crash, put it well when he pointed out that Wall Street developed a "culture of irresponsibility," which involved one person passing on risk to another until a risky financial product was finally bought by someone who didn't understand either the risk or even how the bond or derivative actually worked. "Meanwhile," said the president, "executive compensation—unmoored from long-term performance or even reality—rewarded recklessness rather than responsibility."

Privatizing Gains and Socializing Losses

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